WESTERN ASSET MANAGED MUNICIPALS FUND INC.
Fitch Ratings has assigned an 'AA' long-term rating to the Series 2 variable-rate demand preferred shares (VRDP shares) issued by
Fitch has also affirmed the 'AA' long-term ratings assigned to the Series 1 VRDP shares of MMU.
In addition, Fitch has assigned an 'F1+' short-term rating to the Series 2 VRDP shares and affirmed the 'F1+' short-term rating assigned to the Series 1 VRDP shares.
The rating actions are taken in connection with the fund merger described below.
KEY RATING DRIVERS
The ratings are supported by:
Sufficient asset coverage provided to the preferred shares as calculated per the fund's overcollateralization (OC) tests;
The structural protections afforded by mandatory de-leveraging provisions in the event of asset coverage declines;
The legal and regulatory parameters that govern the fund's operations. The short-term rating of the VRDP shares primarily reflects:
The credit strength of
The terms and conditions of the purchase agreements;
The capabilities of
FUND MERGER
Today, Western Asset announced the closing of a fund merger whereby target fund
As a result of the merger, each share of MNP common stock has converted into an equivalent dollar amount of MMU common shares. MMU will not issue fractional shares to MNP stockholders and will pay cash to each former holder of MNP common stock in an amount equal to the net asset value of the fractional shares of MMU common stock that the investor would otherwise have received in the merger.
Prior to, and in connection with, the closing of the merger, the outstanding auction rate preferred shares (ARPS) of MNP and the rated and outstanding ARPS of MMU were redeemed. As a result, the outstanding Series M, Series T, Series W, Series Th and Series F ARPS of MMU have been marked paid in full by Fitch. The ARPS issued by MNP were not rated by Fitch.
Also, prior to and in connection with, the closing of the merger, MMU issued and delivered to each stockholder of MNP's Series 1 VRDP shares newly issued Series 2 VRDP shares of MMU with the same aggregate liquidation preference and terms as the now-redeemed Series 1 MNP VRDP shares, and the Series 1 VRDP shares of MNP have been marked paid in full by Fitch.
FUND PROFILE
MMU is registered as a non-diversified, closed-end management investment company under the Investment Company Act of 1940 (the 1940 Act). The fund's investment objective is to seek a high level of current income exempt from federal income tax, as is consistent with preservation of capital. Under normal market conditions, the fund will invest at least 80% of its total assets in municipal obligations rated investment grade at the time of investment.
LEVERAGE
As of today, MMU has outstanding
In a TOB transaction, the fund transfers municipal bonds into a trust that issues two types of securities: short-term floating rate securities sold to third-party investors, and residual inverse floating rate interests that are issued to the fund that provided the municipal bond collateral to the TOB trust. Cash received from the sale of the short-term floating rating securities can be used by the fund to purchase additional fund assets.
Although this creates a degree of subordination risk for MMU's preferred share investors, Fitch believes the risk is manageable. The rights of the holders of the floating rate securities to receive payments of principal and interest are fully secured by collateral of the applicable fund and are senior to the rights of holders of the rated preferred shares to receive dividends. The Fitch net OC test quantifies subordination risk by assessing asset coverage to the rated obligations after first repaying liabilities that are senior in the capital structure and the fund has Fitch net OC test results in excess of 100% at the assigned rating level. In addition, there is minimal refinancing risk associated with the rated preferred shares. The Fitch OC test results indicate the fund is sufficiently liquid to fully repay all of their leverage within a relatively brief (45 day-60 day) period, even during a period of substantial stress.
Further, as maturity approaches, the VRDP preferred share transaction documents provide for a liquidity account that segregates assets in an amount at least equal to that of maturing securities and to converts the segregated assets to more liquid securities closer to the maturity date-minimizing the risk of the fund being forced to liquidate portfolio assets to provide for redemption of the preferred shares. The ARPS are perpetual preferred shares with no stated legal maturity date, which mitigates refinance risk.
DERIVATIVES
The fund does not currently use derivatives for hedging or speculative purposes.
ASSET COVERAGE
As of the review date, the fund's asset coverage ratio, as calculated in accordance with the Fitch total and net OC tests (Fitch OC tests) per the 'AA' rating guidelines outlined in Fitch's closed-end (CEF) fund criteria, was in excess of 100%. This is the minimum asset coverage guidelines required by the fund's governing documents.
The Fitch OC tests calculate standardized asset coverage by applying haircuts to portfolio holdings based on riskiness and diversification of the assets and measuring their ability to cover both on- and off-balance-sheet liabilities at the stress level that corresponds to the assigned rating.
As of the review date, MMU's effective leverage ratio was below 45%, the maximum allowed by the governing documents of the VRDP shares.
As of the review date, the MMU's asset coverage ratio, as calculated in accordance with the 1940 Act, was in excess of 225%. This is the minimum asset coverage ratio required by the fund's governing documents.
ARPS STRUCTURAL PROTECTIONS
Should the asset coverage test decline below the minimum threshold amount (as tested on the last business day of each month), the governing documents require the fund to alter the composition of its portfolio toward assets with lower discount factors (for Fitch OC tests), or to reduce leverage in a sufficient amount (for both the Fitch OC tests and the 1940 Act test) to restore compliance within a pre-specified period consistent with Fitch criteria.
VRDP STRUCTURAL PROTECTIONS
For the VRDP shares, a breach of the effective leverage ratio is a breach of the fee agreement with the liquidity provider, and, at the option of the liquidity provider, may result in mandatory tender of VRDP shares for remarketing. However, in the event of a breach, Fitch expects the fund to redeem sufficient VRDP shares to restore compliance. The effective leverage ratio is tested daily.
For the asset coverage and effective leverage ratio tests, the total market value exposure periods (i.e. the pre-specified time period allotted for valuation, cure and redemption in the event of a breach) are consistent with Fitch's criteria.
VRDP PURCHASE OBLIGATION
The short-term ratings assigned to the VRDP shares of the fund are directly linked to the short-term creditworthiness of liquidity provider
The VRDP shares are supported by a purchase agreement to ensure full and timely repayment of all tendered VRDP shares plus any accumulated and unpaid dividends. The purchase obligation under the purchase agreement is unconditional and irrevocable.
The VRDP shares purchase agreement requires the liquidity provider to purchase all VRDP shares tendered for sale that were not successfully remarketed. The liquidity provider must also purchase all outstanding VRDP shares if the fund has not obtained an alternate purchase agreement prior to the termination of the existing purchase agreement or following the downgrade of the liquidity provider's short-term rating below 'F2' (or equivalent).
INVESTMENT MANAGER
LMPFA serves as the fund's investment manager and provides administrative and oversight services to the fund. LMPFA delegates the day-to-day portfolio management of the fund to Western Asset, the fund's subadvisor. Western Asset is subject to the supervision of the fund's Board of Directors and LMPFA.
LMPFA and Western Asset are indirect, wholly-owned subsidiaries of
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade of the 'AA' long-term ratings is not currently possible as Fitch's CEF criteria effectively caps CEF long-term ratings at 'AA'.
There is no potential for upgrade of 'F1+' short-term ratings as this is the highest possible rating on Fitch's short-term rating scale.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The ratings assigned to the VRDP shares may be sensitive to material changes in the leverage composition, portfolio credit quality or market risk of the fund, as described above. A material adverse deviation from Fitch guidelines for any key rating driver could cause the ratings to be lowered by Fitch.
Certain terms relevant to key structural protections of the VRDP shares, including the minimum asset coverage and the effective leverage ratio are set forth in the fee agreements relating to the purchase agreements and are renewed on a periodic basis. Any future changes to these terms that weaken the structural protections may have negative rating implications.
A material adverse decline in the credit strength of
The fund has the ability to assume economic leverage through derivative transactions, which may not be captured by the minimum asset coverage test or effective leverage ratio. The fund does not currently engage in derivative activity. Such activity is limited by the investment guidelines of the fund and could run counter to its investment objectives of achieving tax-exempt income. Material derivative exposures in the future could have potential negative rating implications if it adversely affects asset coverage available to rated preferred shares.
The ratings could be downgraded if asset coverage cushions erode as a result of market volatility, or if Fitch believes the assets the fund invests in are unlikely to retain sufficient liquidity and price stability at the current rating stress levels. Based on the composition of the merged portfolio of MMU and MNP as of the review date, the consolidated fund could withstand a market value decline of 47% before breaching Fitch's OC test results at the assigned rating level. Fitch deems a sustained breach in Fitch OC test coverage as unlikely, as Fitch believes the fund would delever or alter the portfolio composition toward lower discount factor assets to the extent needed to cause the rated securities to maintain passing Fitch OC test margins at the assigned rating levels.
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